A Wealth Tax Would Look Beyond Income

By ANNA BERNASEK

February 9, 2013

INCOME tax rates have recently been raised slightly for some affluent people, and there is pressure for additional increases. But some economists say raising marginal income tax rates on high earners may miss the mark.

One reason is that the truly wealthy employ all kinds of legal means to minimize their tax liability, including shifting income around the world, deferring gains on their assets and many other sophisticated strategies. Another, though, is that taxes on ordinary income simply don’t apply to inheritance or investment, principal sources of wealth.

Under legislation that Congress approved on New Year’s Day the top marginal income tax rate for 2013 has risen to 39.6 percent from 35 percent for individuals on ordinary income over $400,000 and for couples on income over $450,000, while tax deductions and credits start phasing out on income as low as $250,000. But what is being taxed is often just a small portion of the income and wealth of the very richest Americans; unearned income, including unrealized gains and gains on investments, is either not taxed or taxed at a fraction of the top rate on wages.

Taxing wealth in addition to income is one way to make sure that the rich contribute more to government coffers. That would essentially be a tax on household assets like property, stocks, bonds, unincorporated businesses, trusts, art and yachts.

The idea is to aim at the wealthiest part of the population, perhaps the top 1 percent, a group that has seen the most significant and consistent accumulation of wealth over the last few decades.

“A wealth tax is an attempt to fill the holes in income tax,” said Douglas A. Shackelford, a tax expert at the University of North Carolina. “The primary hole is unrealized capital gains. That’s behind the big buildup of dynastic wealth.”

COUNTRIES like Canada have a tax on asset appreciation, based on the value of the assets at the time of the owner’s death. The United States does not, and the tax code contains a huge loophole through which to pass wealth to one’s heirs.

Here is how that can work in practice:

A billionaire can borrow against his stocks, art and real estate, and spend that borrowed money without paying tax. All he has to do is pay interest on the loan. When he dies, his heirs can sell the assets to pay off the debt. Under an existing rule known as the “step-up in basis,” no matter how much the assets have appreciated in value, no one will owe income tax on that gain. And the rest of his fortune goes to his heirs without anyone ever paying income taxes on the appreciation in the assets.

Professor McKinnon’s plan would require households to list all domestic and foreign assets annually. There would be a $3 million wealth exemption, which, in his estimation, would exclude more than 95 percent of the population. The remainder would be subject to a flat tax of about 3 percent of household wealth.

In Europe, in addition to a wealth tax, many countries have a value-added, or consumption tax. Because the idea of a consumption tax is politically unpopular in the United States, he said in an interview, “I think the case is even stronger in the U.S.”

“Plus,” he added, “the income tax is a poor vehicle for hitting the wealthy.”

Other economists say that a wealth tax would also address other problems.

“Wealth inequality and lack of access to opportunity is destroying the meritocratic aspects of our economy,” said Daniel Altman, an economist at New York University and a former member of the editorial board of The New York Times. “That will cost us growth in the long run.”

Mr. Altman proposes replacing the income tax with a wealth tax. He estimates that a flat wealth tax of 1.5 percent would be more than enough to replace the revenue from current income, estate and gift taxes. But he proposes establishing tax brackets according to wealth levels. For instance, no tax might be imposed for a household’s first $500,000 in wealth, 1 percent for the next $500,000 and 2 percent for wealth above $1 million.

Proponents of a wealth tax also say it would encourage innovation and risk-taking because it wouldn’t tax wealth in its early phases, but only after it has been amassed.

There are several main criticisms. For one, valuing unfamiliar assets — say, private businesses or art collections — would not be easy. A related issue is liquidity, as an owner may not be able to readily obtain cash based on the value of the assets in question. And some fear a negative effect on capital formation.

There are also possible legal roadblocks. Matthew J. Franck, writing for National Review Online, said instituting a wealth tax might require a constitutional amendment. A similar concern haunted proponents of the income tax until ratification of the 16th Amendment in 1913.

“Should we reform the income tax, the estate tax or bring in a third tax like the wealth tax?” asked Professor Shackleford at the University of North Carolina. “We have to do something. There’s a tremendous amount of tax escaping because we don’t tax the deceased and we don’t tax the heirs.”